Economics

Hedge fun

WHAT, exactly, is going on? This whole global bail-out thing was supposed to turn the crash into a soothing gradual bear market, and yet volatility indexes remain off the charts, and 10% swings are, if anything, increasing. What's the deal?

One important issue that we continue to mention is that credit market normalcy isn't going to happen immediately, and neither is it a sure thing. Calculated Risk has put together a list of credit indicators and begun tracking them, and progress on those fronts is slow and halting. This is a source of significant uncertainty.

But another story—one that's likely to grow in importance—is the stress we're seeing on hedge funds. The news today includes reports that Citadel's biggest hedge fund has lost perhaps 30% of its value this year. Hedge funds, ostensibly aimed at profiting in all circumstances, have followed the market down in 2008, unnerving some of their investors.

How much so? Well, the Financial Times (via Yves Smith), notes that $43 billion was withdrawn from American hedge funds in September alone. As Ms Smith mentions, America's hedge fund industry is smaller than London's, suggesting the global flight could be much worse. But here's the really fun part:

JPMorgan Chase has estimated that hedge fund outflows could total up to $150bn over the coming year. As investors take their money out of hedge funds, the funds have to sell assets.

But because they use so much borrowed money, the amount of potential asset sales is far larger. For example, JPMorgan expects that an outflow of $150bn will lead to sales of about $400bn.

Ah, leverage. Perhaps the move out of hedge funds will be calm and orderly. Stranger things have happened, no? But the stage certainly seems set for yet another non-bank bank run, with a flight to security generating asset dumps that depress prices and produce an even faster flight to security.

UPDATE:

Highland Capital Management LP will close its flagship Highland Crusader Fund and another hedge fund after losses on high-yield, high-risk loans and other types of debt, according to a person with knowledge of the decision.

Highland, whose total assets under management has shrunk to about $33 billion from $40 billion in March, will wind down the Crusader fund and the Highland Credit Strategies Fund over the next three years, said the person, who declined to be named because the decision isn't public. The hedge funds had combined assets of more than $1.5 billion.

The story also notes that September was the worst month for hedge funds since LTCM went down in 1998.